By Tom Grandy, Founder
A line of credit can be both a blessing and a curse. Every business, large or small, should have a line of credit set up. Potential problems arise in two ways. The first is when the line of credit is improperly used. The second deals with changes in the economy that eventually ripple through the banks and then directly to you, the business owner.
The overall purpose of a line of credit is for short-term borrowing against receivables. As an example, let’s assume a $30,000 check is expected to arrive this week which will cover payroll and a few additional overhead costs that are coming due. The phone rings and you are informed that it is going to be another 30-45 days before that $30,000 check arrives. That is when the line of credit kicks in. The company goes to the line of credit and borrows $30,000. Payroll is met and the overhead costs that need to be paid are paid. Thirty to forty-five days later the $30,000 check arrives. The Line of Credit is paid off and all is good. That is how it is supposed to work. But that is not always the case.
Lines of Credit become abused when they are used for things other than short-term borrowing against receivables. Once a line of credit is set up it can be used any time for any reason. Ghee, we need another $10,000 worth of inventory. That’s a simple solution, the company utilizes its line of credit. Now another vehicle is needed. Sure, the owner could go to the bank or dealership, fill out papers and probably get a loan but that takes time and effort. It is a lot easier to simply borrow the needed money from the line of credit. The money is already approved and is readily available. All you need to do is write a check.
As time goes by an additional $5,000 or $10,000 need pops up resulting in more borrowing from the line of credit. Before you know it the balance on the line of credit is up to $75,000! It hasn’t been a problem however, since the company is invoiced for interest on a quarterly basis, and it’s been paid. All goes well, until…
You may, or may not, be aware of the statement on the back of the line of credit you signed. It plainly states (in bold letters or small print) “This Line of Credit may be called in full at any point in time.” Ouch!
When the economy changes (ESG scoring begins taking place, housing tumbles, cost of living skyrockets, the stock market falls, etc.) it eventually ripples into the banking industry. The net result is that money gets tight, and borrowing is difficult. When the banks get nervous, they begin looking more closely at their customers’ accounts. Guess which group of accounts the bank looks at first? Bingo, you are right. They start reviewing everyone that has a line of credit.
Now keep in mind the perfect line of credit customer is one that borrows frequently but also pays their line of credit back to zero at least once or twice a year. That is the perfect customer.
The company we looked at earlier had allowed their line of credit to climb to $75,000 with no immediate plans to pay it back, outside of the interest payment. That is a NOW problem. Before long the company owner is going to get one of two phone calls.
Phone Call #1 – Hello Mr. Jones. We have just turned your $75,000 balance on your line of credit balance into a loan with monthly payments of $1,800 per month…starting next month. Thank you.
Phone Call #2 – Hello Mr. Jones. Remember that $75,000 balance you owe us on your line of credit? Well, we would like that paid in full by the 15th of next month. Thank you.
These calls are being made now! If you have a line of credit, make every effort to pay it off as soon as possible. At the same time, initiate a new company policy that the line of credit will only be used for its intended purpose, which is short-term borrowing against receivables.
If the company finds itself in a position of borrowing routinely on their line of credit to pay bills, then take it as a RED FLAG that there is a root problem somewhere else within the company. 95 percent of the time that root problem ends up being improper labor pricing.
If you are not sure your pricing is set properly then consider purchasing a copy of Grandy & Associates’ book entitled Profitable Labor Pricing for Trades Contractors. It will literally “walk” the user through 10 simple worksheets which will produce the needed hourly rate, in each department, to be profitable. The book is only $19.45 which includes shipping. Order today.
